RBI Launching Inflation Indexed Bonds in India on 4-Jun-13
As indicated in the 2013-14 budgets, RBI has announced last week that it is planning to launch Inflation Indexed Bonds in India on June 4th, 2013. In this article we would discuss about Inflation Indexed Bonds (IIB), its benefits and drawbacks.
Inflation Indexed Bonds in India
RBI is planning to launch first tranche of IIB’s on June 4th, 2013 and aiming to sell the bonds for Rs 10 Bn to Rs 20 Bn (Rs 1,000 Crores to Rs 2,000 Crores). These bonds would be issued from subsequent months on last Thursday of every month. RBI is planning to sell such bonds upto Rs 12,000 Crores to Rs 15,000 Crores by end of Mar-2014 (FY 2013-14).
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Purpose of Inflation Indexed Bonds
These indexed bonds are issued to attract household savings so that investors would reduce the investments in gold. Government of India and RBI aims that these will protect savings of poor and middle class investors from inflation, incentive the household sector to save in financial instruments, rather than buying gold.
How does Inflation Indexed Bonds work?
IIB’s would have a coupon rate. These bonds would consider Wholesale Price Index (WPI) of the corresponding 4 months ago. Means there would be a lag period of 4 months. 10 years bonds will have a fixed coupon rate and its principal value will be linked to Wholesale Price Index (WPI). Periodic coupon payments are paid on adjusted principal. These bonds would provide protection to both principal and coupon payment. At maturity, the adjusted principal or the face value, whichever is higher would be paid. Let me explain with an example
If you have invested Rs 100 in these bonds which has a coupon rate of say 3% per annum. In a year if the Wholesale Price index is 10%, then the revised adjusted principal is Rs 110 (Rs 100 x 10% inflation added to principal) and the interest would be Rs 110 x 3% = Rs 3.3.
A sample table showing the returns at various WPI rates
*Returns indicated are per annum
What are the benefits of Inflation Indexed Bonds?
Inflated adjusted returns: Since these are linked to WPI index + coupon rate, returns would be over and above the WPI index. These would be good investments who want to lock their money and protect against inflation
Risk free investments: Since these are issued by Government of India, these are risk free investments.
What are the drawbacks of Inflation Indexed Bonds?
1) Using Wholesale price index instead of Consumer Price index: IIB’s are widely successful in US, UK, France, Germany and Canada. However these countries use Consumer price index (CPI). India is only country where WPI is being used for such bonds. Inflation can be measured accurately to a greater extent through CPI. In India current CPI is 9%+ whereas the WPI index is 4.9% (Apr-13).
2) Can investors divert from investments in Gold: One of the purpose of these bonds is to divert some of the investments to IIB’s so that investors would stay away or reduce their exposure to Gold. Investors who have been investing for long time in Gold would continue to invest. However investors, who are investing in bank FD or any other fixed income options, may divert some of their savings to these IIB’s.
3) IIB Vs Debt instruments: There are several debt instruments where the returns are between 7% to 11% per annum (like debt mutual funds, NCD, Company FD, Bank FD etc.) Even if we assume the coupon rate would be 2% and inflation at 5%, the maximum returns would not exceed 7% per annum unless the Wholesale price index increases. Investors may not be willing to invest in such low returns bonds.
4) Liquidity: Currently, since these are new products, it is not very clear as to how they can be sold before maturity. An investor need to keep this point in mind. It may take another 1 year to get clarity about how he can take out money in case of any urgent need.
IIB’s are not new. These are issued by RBI earlier, however there was poor response.
How to buy Inflation Indexed Bonds
We are yet to get clarity on the process of buying such inflation indexed Bonds. Hopefully, we should be able to get the process from RBI in the next 2 weeks.
Conclusion: I may look at buying these Inflation Indexed bonds if the coupon rate is 3%+ per annum, Liquidity issue are taken care and the process of buying such bonds is made easier.
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Inflation Indexed Bonds in India